Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that La Française de l'Energie S.A. (EPA:LFDE) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is La Française de l'Energie's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 La Française de l'Energie had debt of €22.1m, up from €18.8m in one year. However, it also had €4.89m in cash, and so its net debt is €17.2m.
How Strong Is La Française de l'Energie's Balance Sheet?
We can see from the most recent balance sheet that La Française de l'Energie had liabilities of €19.2m falling due within a year, and liabilities of €26.2m due beyond that. Offsetting these obligations, it had cash of €4.89m as well as receivables valued at €1.71m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €38.9m.
La Française de l'Energie has a market capitalization of €127.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if La Française de l'Energie can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, La Française de l'Energie made a loss at the EBIT level, and saw its revenue drop to €7.7m, which is a fall of 13%. That's not what we would hope to see.
While La Française de l'Energie's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at €130k. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled €6.6m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example La Française de l'Energie has 2 warning signs (and 1 which is a bit concerning) we think you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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